Cooper and Kovacic (2012) on Regulators

James C. Cooper and William E. Kovacic, “Behavioral Economics: Implications for Regulatory Behavior.” Journal of Regulatory Economics 41: 41-58, 2012.

• The principal is the legislative or executive overseer, whose preferences are assumed to be short-sighted. The agent is the regulator, who thinks she knows the (socially) optimal policy – but she might be biased -- and pays a price when the policy choice varies from what she views as best. The regulator also possesses career concerns that favor obeying the legislator. 

• If the regulator puts no weight on pleasing her boss, or if the overseer is unable to punish a wayward agent, the regulator will choose what she thinks is the first-best policy. 

• Behavioral biases (like availability, optimism, hindsight) make the regulator more like the short-term politician. The call to “do something” might push the confirmation bias in the direction of the principal’s preferences, too. The status quo bias and the confirmation bias have ambiguous implications for the regulator’s policy choices. 

• Regulators only hear about some issues when intervention is requested by a constituent – creating an anchoring effect. Publicly announced positions also generate an anchor. 

• Regulators do not operate in a competitive market environment, and their sources of feedback are not as strong or timely as firms often receive – so biases can persist. Poor regulators generally do not exit the profession. Indeed, the feedback received from legislators is likely to result in regulators who are too short-term oriented, or whose biases make them behave as if they were. 

• Internal and external adversarial proceedings might aid regulatory choices. The regulators can set up an A-Team and a B-Team and let them present their cases. (The FTC has economists work up a case independently of lawyers.) More ex post evaluations, focused on outcomes, not outputs, along with longer tenure for regulators, could help.